Banks Stay Bond-Addicted as Cash Hoarders Prevail: Japan Credit

Pedestrians walk through a business district in Chiba City, Japan. Regional banks bought a net 1.9 trillion yen of government bonds this year through May, while city lenders sold 12.2 trillion yen of notes, according to data from the Japan Securities Dealers Association. Photographer: Tomohiro Ohsumi/Bloomberg

Lenders, which loaded up on debt as loan demand stagnated
in recent years, want to reduce the risk of losses on their 151
trillion yen ($1.5 trillion) in holdings as the bond market
gyrates and yields climb following efforts by the government and
central bank to spark inflation.

Yet more than six months after Abe took office, even as
banks try to trim their bond holdings, households and companies
aren’t taking out enough loans, saddling lenders with record
excess deposits. Abe’s vision for ending deflation, stoking loan
demand and creating economic growth -- termed Abenomics --
remains “far removed from the current reality,” said Satoshi
Yamada, a debt-trading manager for Okasan Asset Management Co.,
which oversees the equivalent of $11 billion in assets.

“There’s no other place than JGBs where banks can park
their cash,” said Teruyoshi Sotome, a Tokyo-based senior bond
strategist at Mizuho Securities Co., one of Japan’s 25 primary
dealers obliged to bid at government debt sales. “I believe
they will resume buying them once volatility calms.”

Regional banks are more vulnerable to swings in yields than
larger lenders because they hold bonds with a longer duration.
Credit demand in rural areas may pick up too slowly to stop
local banks from relying on interest income from the securities,
the International Monetary Fund said in May.

Kuroda’s Plan

Bank of Japan Governor Haruhiko Kuroda, handpicked by Abe
this year, is stepping up government bond purchases to achieve 2
percent inflation and free up lenders to deploy more funds into
the economy. His policy spurred an increase in long-term
interest rates, which have remained elevated as U.S. Treasury
yields climb after the Federal Reserve indicated it may start
tapering its monthly bond buying later this year.

Yields on Japan’s benchmark 10-year notes swung between a
record low of 0.315 percent on April 5, the day after the Bank
of Japan announced its plan to double bond purchases, to as high
as 1 percent in May. The securities yielded 0.89 percent at 3:41
p.m. in Tokyo.

Lenders including Tokyo-based Mitsubishi UFJ Financial
Group Inc., Sumitomo Mitsui Financial Group Inc. and Mizuho
Financial Group Inc. cut their sovereign note holdings for a
second month to 151.3 trillion yen in May, Bank of Japan data
show. Banks’ stockpiles of sovereign debt peaked at a record 171
trillion yen in March 2012.

Auction Demand

An auction of 2.2 trillion yen of 10-year government bonds
today attracted bids valued at 2.41 times the amount available,
the weakest demand since March, according to Ministry of Finance
data.

Still, Mitsubishi UFJ President Nobuyuki Hirano said May 15
that Japan’s biggest bank will remain a stable holder of the
nation’s debt, which the IMF estimates will swell to 245 percent
of the economy this year. Masaaki Tani, chairman of the Regional
Bankers Association of Japan, told reporters June 12 that
government bond investment is still important for local lenders
and that he expects yield fluctuations to subside.

“Banks have been swamped in JGBs, so it’s hard for them to
get out,” said Yamada of Okasan, based in Tokyo. “As long as
the economic outlook remains uncertain, banks have no choice but
to channel their excess funds into bonds, which could bog down
Abe as well.”

Deflation Legacy

Lenders increased government bond holdings about fivefold
over the past 15 years as loans shrank and deposits swelled amid
deflation. Price declines dissuaded borrowers by increasing the
real value of debt, and the Bank of Japan’s policy of keeping
benchmark interest rates close to zero made loans less
profitable.

The gap between deposits and credit continues to widen even
as Abe seeks to beat deflation with his three-pronged strategy
of fiscal spending, monetary stimulus and deregulation.

Excess deposits over loans surged to an unprecedented 185.1
trillion yen in May, according to central bank data. Deposits
rose 3.7 percent from a year earlier, the most in 11 years,
outpacing a 2.1 percent increase in lending. Japanese companies’
stockpile of cash reached a record 225 trillion yen in the first
quarter, an amount bigger than Italy’s economy, Bank of Japan
figures show.

Deposit Deluge

“Japanese banks already have more deposits -- at almost no
cost -- than they know what to do with,” said David Marshall,
an analyst at research firm CreditSights Inc. in Singapore.
“The main problem in Japan is the lack of loan demand, not that
banks are unwilling or unable to lend.”

Japan’s notes maturing in more than a year lost 1.8 percent
in the March-June period, the worst quarterly performance since
the three months ended September 2003. Historical volatility for
the bonds climbed to a five-year high of 3.98 percent on June
25, based on a 60-day reading, according to data compiled by
Bloomberg and the European Federation of Financial Analysts
Societies.

Swings in the government bond market have “cast a shadow”
over lenders’ investments in the securities, and there are few
other places to put deposits, Standard & Poor’s said in April.

Abenomics Dream

“There was a dream in Abenomics that banks can increase
lending as the economy recovers,” said Sotome of Mizuho
Securities. “But the reality is that there’s so much
uncertainty that makes portfolio rebalancing difficult.”

A Bank of Japan report in April examining potential losses
at banks from rising yields found that if interest rates climb 1
percentage point across all maturities, Japan’s biggest lenders
would incur 3.2 trillion yen of unrealized capital losses. A 3
percentage-point increase would lead to 8 trillion yen in
capital losses, the central bank estimated.

Bonds are a relatively liquid asset that can be sold
easily. Banks are unlikely to fuel a selloff in the bond market
like one that took place in 2003, when prices plummeted,
according to analyst Shogo Fujita of Bank of America Corp.
Lenders, especially in big cities, have been containing risks by
shortening the duration of their holdings.

In 2003, 10-year yields surged from about 0.4 percent in
June to 1.7 percent three months later. That violated banks’
internal restrictions based on the so-called value-at-risk model
for estimating potential JGB losses, triggering a further sell-off. The rout was dubbed the “VaR shock” by traders.

Reduced Duration

The average maturity of sovereign notes held by major banks
was longer than three years at that time, compared with around
2.5 years at the end of last year, Bank of Japan data show.

“We’re a long way away from 2003’s VaR shock,” said
Fujita, chief Japanese bond strategist at Bank of America
Merrill Lynch in Tokyo. “In the short term, banks may have to
sell JGBs as the high volatility that we’ve been seeing recently
has made them risky assets. But at some point in the near
future, banks’ money will find its way back into JGBs.”

Lenders have improved their risk management since 2003,
according to Takeshi Kunibe, chairman of the Japanese Bankers
Association, the country’s biggest banking lobby.

Net Sellers

The IMF said in May that Japanese banks could become net
sellers of government bonds in the next few years as the Bank of
Japan snaps up notes, helping to reduce their sensitivity to a
jump in yields.

Kuroda and his policy board members unveiled a plan in
April to double monthly debt purchases to more than 7 trillion
yen. That’s about 70 percent of planned issuance from the
world’s most heavily indebted government.

While the monetary-policy shift may prompt major lenders to
further expand overseas, regional banks will probably remain
more exposed to interest-rate moves by keeping a portfolio
centered on the securities, the IMF also said.

“One risk scenario we see is that credit demand in
regional economies is slow to pick up, then regional banks may
continue to rely on interest income from longer-duration JGBs,
making them more susceptible to interest-rate risks,” said
Serkan Arslanalp, a senior economist at the fund’s monetary and
capital-markets department. “This may amplify especially in the
absence of a growth strategy.”

Investing Abroad

The nation’s so-called megabanks -- Mitsubishi UFJ,
Sumitomo Mitsui and Mizuho -- have been investing in lenders
abroad, where loan profitability is higher. Mitsubishi UFJ said
today that it plans to buy as much as 75 percent of Thailand’s
Bank of Ayudhya Pcl for 560 billion yen through a tender offer.
That would be the largest banking takeover in Thailand. Sumitomo
Mitsui agreed in May to buy Indonesia’s PT Bank Tabungan
Pensiunan Nasional for about $1.5 billion.

In contrast, regional banks, which have less scope to
expand overseas, are struggling to increase profit through
lending. The average net interest margin among the 85 companies
on the Topix Banks Index is 1.3 percent, the lowest in Asia,
according to data compiled by Bloomberg. New long-term loan
rates averaged 0.92 percent in May, BOJ data show, little more
than the 10-year bond yield.

Some local lenders have yet to see signs that Abe’s growth
policies are lifting their economies even as monetary easing
weakens the yen, benefiting exporters.

In the southern prefecture of Kagoshima, Japan’s biggest
beef and pork producer, a lower yen is “troublesome” because
it boosts prices of imported feed grains for livestock,
according to Kagoshima Bank Ltd. President Motohiro Kamimura.

‘Hard Time’

“Abenomics is just giving local regions a hard time,”
Kamimura said in an interview. “Banks want to lend badly, even
if they have to take some risks, but the reality is that there
is nobody to borrow.”

Kamimura said he wants to buy government bonds when yields
rise after selling about 100 billion yen of the notes because of
the recent increase in volatility. Kagoshima Bank forecasts
lending income will remain unchanged at 45.8 billion yen for the
year ending March 2014.

Regional banks bought a net 1.9 trillion yen of government
bonds this year through May, while city lenders sold 12.2
trillion yen of notes, according to data from the Japan
Securities Dealers Association. Local banks hold securities with
an average maturity of four years, about double the duration for
megabanks, said Tani of the regional banking lobby.